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U.S. markets pulled back last week with large cap equities falling 2.05% and Mid and Small caps following suit, dropping 1.6% and 3.96% respectively. While this could be a bit of a normalization from the market spike following the election, it is more likely caused by concerns that the Fed may slow down their pace of interest rate cuts. We can see this in the rate probabilities getting priced in the markets. Previously, markets were pricing in a 75% probability that the Fed would cut rates 25 bps in December, however as of the end of last week, that probability has fallen to just 62.5%.
There were several reasons for these concerns with inflation showing some recent stubbornness in its fall down to the 2% rate that the Fed is targeting. CPI came out last week and for the most part was unchanged from the previous month. The headline inflation rate grew by .2% in October, which is where it has been since the June reading of -.1%. There was also a slight tick up on the year over year rate to 2.6% compared to the previous month of 2.4%. On the core side nothing changed from the previous month as the MoM and YoY remained consistent at .3% and 3.3% respectively.
Some of the key areas were food and energy prices in the overall number and shelter prices in the core. Food prices grew at a slower rate compared to previous months, yet still grew .2% for the month. Shelter, which has remained high, increased by 0.4%, accounting for over half of the total monthly inflation. Energy prices declined, with gasoline prices falling .9% in September helping to offset some of the inflationary pressures from the other sectors.
Retail sales was another release that gave the markets a reason to believe the Fed may need to back off on the speed of rate cuts. Spending not only came in stronger than expected in October at .4% vs expectations of only .3%, but September was revised to .8% which is double the original estimate. A big portion of this gain was from the automotive sector as auto sales rose 1.6% for the month. Other notable areas were electronics and appliances rising 2.3% and foodservice & drinking places increasing .7%. While spending has moderated to just slightly above the average rate, these results to point to consumers that are still willing to spend.
It was not just the economics that gave investors some worry, Fed Chairman Powell commented last week that as we have continuing economic growth, a job market that is still solid and an inflation rate still above the 2% target, they believe they do not need to rush to lower interest rates. He stated that the Fed will likely cut rates slowly and deliberately in the coming months, all but stating outright that given current economic conditions, they will be letting up on the gas a bit going forward.